VAL CO:R:C:V 544694 CRS

District Director
U.S. Customs Service
477 Michigan Avenue
Detroit, MI 48226

RE: Internal Advice 1/91; foreign-trade zones; payments for design and development costs; component parts; 19 C.F.R.  146.65; dutiable value; price actually paid or payable; Generra; indirect payments; apportionment; allocation; Chrysler; total zone value; dead-end development costs

Dear Sir:

This is in reply to your memorandum dated December 28, 1990, under cover of which you submitted the above-referenced internal advice request concerning the dutiability of certain payments made by Ford Motor Company and Mazda (North America), Inc. ("MANA"), to Mazda Corporation of Japan ("Mazda"), as reimbursement for the costs incurred in the design and development of automobiles made in the United States by Mazda Motor Manufacturing (USA) Corporation ("MMUC"). A written submission regarding this matter was made by Baker & Hostetler, counsel for MMUC, in a letter dated December 15, 1991. Submissions dated January 25, 1990, and July 10, 1989, including a prior disclosure, were filed with your office and were also reviewed in connection with this issue. In addition, members of my staff met with counsel at Customs Headquarters to discuss this matter. We regret the delay in responding.


MMUC, the importer of record, purchased automobile components from Mazda, brought them into its Flat Rock, Michigan, foreign-trade subzone (FTSZ; subzone), and there combined them with domestic components to produce finished vehicles which were subsequently sold to Ford and MANA. However, the automobiles manufactured by MMUC were originally designed and developed in Japan by Mazda. As part of the overall transaction, Ford and MANA agreed to reimburse Mazda for costs the latter incurred in connection with the development of vehicles produced by MMUC at the Flat Rock plant. The components at issue consist of entries of non-privileged foreign status merchandise.

The development costs that are the subject of the instant internal advice request pertain to three vehicle programs: the **** program, which includes the **** update for the ****; the **** program and the **** update for the Mazda ****; and the **** program and the **** update for the ****. Within the individual vehicle programs, counsel asserts that payments made by Ford and MANA are attributable to five categories of design and development: styling; engineering; testing; prototypes; and pilot production. Counsel for MMUC contends that the design and development payments should not be dutiable because they represent costs associated with the production of finished vehicles rather than of components. Alternatively, while still maintaining that none of the design and development costs should be added to the price actually paid or payable of the imported components, counsel has proposed the following allocation in respect of the five design and development categories identified above.


The first of these is styling, which consists of assistance provided by Mazda to Ford engineers in the development of clay models, as well as clay models, sketches, color studies and mock-ups performed solely by Mazda. Counsel states that styling activities were directed toward generating a preliminary idea of how a finished vehicle would appear and that no specifications and drawings of individual components were done at this stage of the development process. Consequently, counsel states that no payments attributable to styling should be added to the price actually paid or payable.


Engineering is the second category of design and development. Counsel subdivides this into three areas: planning activities; vehicle engineering activities; and power-train engineering activities. The first of the engineering subdivisions, viz., planning activities, refers to the evaluation of such factors as desired fuel economy and the projected weight and cost of a vehicle, the identification of regulatory compliance issues, and decisions as to what features should be included. This stage of engineering development represented some *** percent of the total work in this area but did not focus on specific components. Still within the realm of engineering, vehicle engineering activities can be further subdivided into "packaging" activities which involved translating design concepts into specifications, and "product development" which counsel has advised primarily involved decisions regarding parts specifications and development. Counsel maintains that the first of these, i.e., packaging activities, should not be considered part of component development. The second aspect of the process, product development, involves engineering calculations in respect of parts specifications, prototype drawings and prototype parts production. These activities represented approximately *** percent of the product development costs charged by Mazda Japan to Ford and MANA for vehicle engineering, with the balance representing packaging activities and various administrative activities. By allocating some administrative costs to parts activities, counsel advises that Mazda Japan estimates that *** percent of the vehicle engineering activities undertaken were attributable to component development. Nevertheless, counsel notes that while these costs may be allocable to component development, many design costs represent "dead-end" expenses, i.e., expenses related to work which is never incorporated into actual production components.

Finally, power train engineering activities concerned work relating to the development of the engine and transmission unit, and the installation of power trains into automobiles. Counsel states that Mazda Japan regards all of the former as related to the development of component parts. In regard to installation, Mazda Japan has estimated that approximately *** percent of the work in this area was related to the development of component parts.


The third area of design and development relates to testing, which can be divided into vehicle testing and power train testing. The former includes, inter alia, crashworthiness, acceleration, and safety performance tests. The testing related not only to entire vehicles but also to individual parts. Mazda estimates that approximately *** of the costs in this area involved component part development. Power train testing also involved both entire vehicles and components. Again, it is estimated that *** of these costs were related to components.

Prototype Development

Prototype development represents the fourth category of design work. Counsel has provided an estimated allocation of these costs for each vehicle program as between vehicle prototype costs and parts prototype costs. The estimate for the **** program is *** percent for vehicle development and *** percent for parts development. For the **** the allocation is *** percent for vehicles and *** percent for parts; for the ****, *** percent and *** percent; and for the ****, *** percent and *** percent.

Pilot Production

The final category of design and development work pertains to pilot production. Counsel maintains that the costs incurred in producing an initial run of vehicles should not be considered dutiable since there was no effect on individual components and the purpose of the work was primarily for the purpose of testing the manufacturing and assembly processes and equipment used to manufacture finished vehicles.

Finally, counsel argues that amounts that relate to certain "dead-end" development costs should not be included in the appraised value. These costs represent work that is never incorporated into finished vehicles.

District Position

The Ford and MANA payments were made to reimburse Mazda Japan for the design and development costs incurred in the production of automobiles at the Flat Rock FTSZ. The payments do not differentiate between amounts attributable to the design of component parts and amounts due in respect of vehicle development. Furthermore, when design costs are incurred, they are not allocated between those attributable on the one hand to components, and those attributable on the other, to finished vehicles. Instead, they are treated as a cost of the particular vehicle program to which they relate, e.g., the **** program. Consequently, it is your position that most, if not all, of the payments made by MANA and Ford as reimbursement for development costs should be included in the appraised value of the parts purchased from Mazda Japan. In regard to "dead-end" expenses, it is your position that these amounts should be included in the appraised value of the finished vehicles transferred from the FTSZ.


The issue presented is what part of payments made to a foreign seller as reimbursement for design and development expenses associated with automobiles manufactured in a FTSZ with imported components, is part of the dutiable value of the imported components.


Section 3(a) of the Foreign-Trade Zones Act, as amended (19 U.S.C.  81c) provides that articles sent into the customs territory after having been produced or manufactured in a FTZ are subject to the laws and regulations affecting imported merchandise. See also, HRL 544250 dated July 26, 1991. In accordance with section 146.65(b)(2), Customs Regulations (19 C.F.R.  146.65(b)(2)), the dutiable value of privileged and nonprivileged foreign merchandise sent into the customs territory from a foreign-trade zone ("FTZ;" "zone") is the price actually paid or payable for the merchandise in the transaction that caused it to be admitted to the zone, plus the statutory additions enumerated in section 402(b)(1)(A)-(E) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C.  1401a). The dutiable value of privileged and nonprivileged foreign merchandise transferred from a zone does not include the cost of international freight and insurance, nor the cost of U.S. inland freight, to the extent these items are part of the price actually paid or payable. 19 C.F.R.  146.65(b)(2). The imported component parts that are the subject of this ruling consist of entries of non-privileged foreign (NPF) status merchandise.

As stated above, dutiable value is based on the price actually paid or payable for merchandise in the transaction that caused the merchandise to be admitted to the zone. The term "price actually paid or payable" is defined by section 402(b)(4) of the TAA as the "total payment (whether direct or indirect...) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller. 19 U.S.C.  1401a(b)(4). Under Generra Sportswear Co. v. United States, 905 F.2d 377 (1990), all payments made by the buyer to, or for the benefit of, the seller or a related party, are part of the price actually paid or payable. On this basis, Customs has held that payments for engineering, development work, etc., are part of the price actually paid or payable for imported merchandise. E.g., Headquarters Ruling Letter (HRL) 545278, dated April 7, 1994; HRL 544381, dated November 25, 1991; HRL 544516, dated January 9, 1991. Here, the payments are made indirectly by Ford and MANA, on behalf of their related-party buyer, MMUC, to Mazda for design and development costs related to the automobiles produced in the Flat Rock subzone with the imported components. We have also held that payments made to the seller by the ultimate U.S. purchaser, rather than by the buyer of the imported merchandise, are indirect payments under section 402(b)(4)(A) of the TAA. E.g., HRL 543967 dated December 17, 1987. Thus, in accordance with Generra and the rulings cited above, it is our position that payments for the design and development of imported components constitute part of the price actually paid or payable.

Counsel also argues that amounts relating to "dead-end" development costs should not be included in the appraised value. While these costs may indeed represent work that is never incorporated into the finished vehicles, it is nevertheless work that is necessary to develop the vehicles and the imported components from which the vehicles are produced. Consequently, it is our position that these amounts are also part of the price actually paid or payable for the imported components in NPF status.

Nevertheless, in the event that the payments are considered part of dutiable value, counsel contends they should be allocated between the imported components and the finished vehicles. Since the vehicles are made from both foreign and domestic components, we think it clear, in this FTZ case, that some portion of the payments represents design work attributable to the domestically produced components; consequently, it is our position that the design payments should be apportioned between the imported NPF components and the domestic components. However, based on the information presented, the parties make no precise distinction between design costs attributable to components and design costs that relate to automobiles. Instead, the payments simply represent amounts for design and development costs incurred in respect of the vehicles produced in the subzone. Having concluded, however, that the payments are in some measure part of dutiable value, it is necessary to determine what part is attributable to the imported NPF components.

The Court of International Trade has held that payments can be allocated. Chrysler Corporation v. United States, No. 93-186, slip op. at 18-21 (Ct. Int'l Trade September 22, 1993). As a general matter, payments should be allocated in a reasonable manner appropriate to the circumstances of the case. See, e.g., 19 C.F.R.  152.103(e)(1), regarding the apportionment of assists. In Chrysler, the court considered whether to apportion certain tooling payments over the total number of products contemplated to be imported, or over the actual number of items manufactured, holding ultimately that the payments should be apportioned over the total number of engines to be produced. Counsel's method of allocation is not based on an objective standard, e.g., total production, but rather is based on a subjective determination as to whether certain design and development costs were incurred wholly or partially for "parts" or for "vehicles." Thus, in the instant case, we find that counsel's method does not allocate the payments in a reasonable manner appropriate to the unique circumstances of the FTZ setting.

However, there does exist an objective standard, based on the production of vehicles produced in the subzone, by which it is possible to allocate the payments as between imported, NPF components and finished vehicles. This method of allocation is based on the total zone value of the merchandise, determined in accordance with the principles of valuation contained in sections 402 and 500 of the Tariff Act of 1930, as amended by the TAA. The term "total zone value" is defined as "the price actually paid or payable to the zone seller in the transaction that caused the merchandise to be transferred from the zone." 19 C.F.R.  146.65(b)(1).

Accordingly, based on the information presented, we have concluded that it is reasonable to the particular circumstances of this case to allocate the design and development payments at issue between the imported component parts and the finished vehicles in accordance with the ratio of the value of the imported NPF components to the total zone value of the merchandise at the time it is transferred from the zone. If additional information is forthcoming, some other reasonable method of allocation may be more appropriate, e.g., direct identification of design and development costs based on accounting records. In this regard, we note that subpart A, Part 162, Customs Regulations (19 C.F.R.  162.1 et seq.), establishes the general requirement for owners, importers, consignees, or their agents, who import merchandise into the U.S. to keep records. Furthermore, section 146.21(a), Customs Regulations (19 C.F.R.  146.21(a)), requires that zone operators maintain recordkeeping systems capable of providing all information necessary to make entry for merchandise being transferred from a zone to the Customs territory.


The payments in respect of the design and development costs at issue should be allocated to the imported components in conformity with the foregoing.

This decision should be mailed by your office to the internal advice requester no later than sixty days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS, and to the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels.


John Durant, Director
Commercial Rulings Division